Whether it happens before the doors open, or after a few years of “bootstrapping” with founder money, every startup reaches the point where it needs outside capital to survive and/or grow. According to Fundable, fewer than 1 percent of startups receive funding from angel investors, and 0.05 percent from VC firms, it can be all too tempting for startups to say yes to anyone that offers the funds they need.
This is usually a mistake. Not all investors are created equal, and not all investors and startups are good fits for each other. Even if you’re desperate for capital, taking money from the wrong investor can sink your business faster than if you have no outside money at all.
Smart entrepreneurs choose their investors as carefully as investors choose startups. Based on my experience connecting hundreds of startups with the right funding sources and then guiding them through the deal-making process, I believe that you should begin the fundraising process by envisioning a “dream team” of investors based upon the following seven criteria.
- What’s your business?
Many investors will specialize in particular industries for two reasons. First, they may feel better able to evaluate investment opportunities in fields where they already have expertise –medical devices, tech, or consumer products.
Second, investors often want to contribute their advice and guidance along with their capital. If they’ve invested in (or lead) a particular category of business before, they may feel better equipped to advise a startup in that field.
- Where are you located?
Many investors prefer to put their money into startups that are geographically close to them, enabling them to visit the companies and learn about its operations. Additionally, there are local programs, grants, accelerators and incubators located across the United States and internationally, that may provide you with funding. You should always start your search for investors in your own “back yard.”
If you are in a place where there are few investors to be found, your location does not have to be a deal-breaker. Network with other startups in your area to see where they have received funding or reach out to via your own connections to find investors in other locales.
- What stage is your business in?
Investors often specialize in different stages of startup development: concept or pre-revenue, first customers, first revenues, first profitability, need for expansion, etc. And every stage of investment has its own “round” – pre-seed, seed, series A, B, C, and so on.
It is critical to know what stage of development your business is in and to show investors a solid execution plan of how you will reach profitability from where you are now.
Equally important is having a solid exit strategy in place – before you seek outside money.
Most investors are looking for a startup to either be acquired or to go public before they will receive the 3X to 10X ROI they want, so you better be able to show investors an exit plan even if you are still raising money in the concept stage.
- How much cash do you need?
Investors have varying amounts of capital they can bring to the table. Angels are usually investing their own money, so their contributions will typically be smaller than funds from super-angels or angel groups. Then there are venture capital (VC) funds and family offices, which are investing other people’s money and often have access to more capital as a result. Determining how much capital you need to raise will help determine which category of investors you pursue.
Another often-overlooked source of money that may fit your business model is crowdfunding, especially if you already have a loyal customer base. Since 2016 companies have been permitted to raise capital directly from the public, with some restrictions. (See the JOBS Act—Titles III and IV for more details.) Depending on your goals, crowdfunding can be a great way to access capital from people who already love your product or service.
- Have you raised capital before? If so, what did you give those investors? And what are you willing to give up in exchange for new money?
Unless your startup was completely self-funded by you and your team, you already have some investors (friends, family, banks, individuals or companies that have put money in at an earlier stage). What did you promise these investors in exchange for their capital, and was it in the form of debt (loans or convertible notes) or equity (shares in the business)? Whenever you are fundraising you need to have a capitalization table (cap table) which shows who owns what percentage of your company. You also need a balance sheet that clearly shows how much short- and long-term debt your business has incurred.
Whenever you are asking a new investor for capital, be very clear as to how much equity you are willing to give away. Too many startup founders have gotten to the end of fundraising only to discover that they have given away so much equity that there is little, or nothing left, to compensate them for their years of hard work. Before you seek new capital, create a waterfall chart: a spreadsheet showing what happens if you take this much money in exchange for this percentage of equity, or if an investor asks for a convertible note that converts to so many preferred shares in a subsequent funding round.
- What else do you need in addition to capital that an investor can provide?
This is the question that too few entrepreneurs ask when choosing investors. Yet the right investor can provide your startup with resources that will have a far greater impact than just new capital. Take a look at your current business and team; decide where you need greater expertise and/or connections. Do you need more market expertise? Better customer insights? Greater technical proficiency? Deeper or wider connections in your industry or region; in academia, or in local or national government? Do you need advisors with financial acumen? Experts in product development, distribution, or manufacturing? Would you benefit from advice from an industry maverick, or a brand builder, or an expert in pivoting businesses from one market to another? The right investor can be a powerful addition and fill in any “holes” in your current team of colleagues and advisors.
- How involved do you want investors to be in the direction of the business?
Many investors will insist on some level of involvement in your business operations, if only to protect their capital. Depending on the stage of your business, they may want a seat on your board; at a minimum, they will expect regular (and timely) updates and financial reports from you. Smart entrepreneurs, however, will regard investors as their partners and collaborators in building more successful businesses. You should choose investors that you look forward to working with, and whose advice and guidance you are willing to listen to.
Use your answers to these seven questions to target twenty to forty investors to research thoroughly before you approach them with your pitch and business plan. Keep revisiting your answers to evaluate these investors at every step of the fundraising process. Remember, anytime an investor gives you money, it is the beginning of a relationship that will last a minimum of three years and a maximum of ten or more, until your business is acquired or goes public. This relationship may be a significant factor in the direction and success of your startup. So choose your investors well and wisely!